Charitable Deduction a Tough Issue for Tax Reform

We’re all for tax reform. We’re all for closing loopholes. That, so far as I can tell, is where the consensus ends.

As you undoubtedly know, Republicans and Democrats sharply divide on what potential revenues gained from loophole-closing and the like should be used for.

Republicans want them used to offset the costs of reducing tax rates, thus making tax reform revenue neutral. In other words, the reform package they have in mind would neither increase the deficit nor raise more revenues.

Democrats, by and large, want a package that would, among other things, raise more revenues from “those who can most afford it,” as Senate Budget Chair Patty Murray puts it.

Trouble is that there’s only so much to be gained from tax code changes narrowly targeted to those “at the top,” whom the President calls on “to do their fair share.”

The largest tax expenditures, i.e., revenues forfeited through deductions, credits and the like, benefit a broad spectrum of middle-class filers, as well as the wealthy.

One of them, though not the largest, is the deduction for charitable donations. Here we’ve got an interesting divide that crosses ideological lines.

President Obama has consistently proposed capping the value of all deductions at 28% of adjusted gross income, though not for all filers.

The latest iteration would apply to households in the top three tax brackets and would include not only itemized deductions, but some earnings (or the equivalent) that are now excluded from taxation, e.g.,  the value of employer-sponsored health insurance.

The revenues gained would partly pay for ending sequestration while still reducing that bugbear, the deficit.

The cap would make the tax code more progressive because deductions are worth more to filers who earn more.

For example, someone in the 15% bracket who claims $10,000 in deductions saves $1,500. Someone in the reinstated 39.6% bracket saves $2,460 more.

But — and for exactly this reason — many nonprofits and the organizations that represent them have raised holy hell every time the cap has been proposed.

It’s those upper-income taxpayers they rely on for a large portion of their funding. Also on us, who effectively subsidize that portion, but without the chance to choose where it goes.

The Congressional Budget Office estimates that the very wealthiest households — the infamous top 1% — will account for 38% of the total value of charitable deductions claimed this year or about $15.2 billion.

No one actually knows how the proposed cap would affect charitable donations, though the experts I’ve read all agree that it would put a damper on them because the deduction provides a financial incentive to give.

The Tax Policy Center estimates that it would reduce individual giving by at least 2.2% and perhaps as much as 4.1%.

This, says the Center for Effective Government, translates into a loss of somewhere between $47 billion and $91 billion over 10 years. A reason it’s campaigning against the cap.

The Center on Budget and Policy Priorities accepts the TPC estimate, but argues that we must also consider increased incentives to give that were created by certain tax provisions in January’s fiscal cliff deal.

These would partly offset the impacts of the cap. So charitable giving would probably drop by 2% or less, it says.

CBPP views the loss as a small price to pay for ending sequestration. Nonprofits that benefit, directly or indirectly, from government grants and contracts will lose far more from further rounds of spending cuts, it says — even as those same cuts increase demands for their services.

The Center for Effective Government isn’t buying this. Nonprofits might suffer as much from reduced charitable giving as from sequestration, it says — some perhaps more.

Besides, its “a false choice” because other tax code changes could more than offset the costs of exempting the charitable deduction from the cap — or even better, converting it to a tax credit, which would make it equally valuable to all taxpayers who donate.

I got started on this issue because nonprofits that depend in part on charitable donations, of course, include those that serve low-income people’s basic needs.

Yet it seems that they’re not the main beneficiaries of taxpayers in the upper income brackets — those who might be inclined to give less if their deductions were capped.

Such organizations could nevertheless lose some funding if Congress caps all deductions. On the other hand, they’ll surely lose funding if it doesn’t replace sequestration with something more sensible.

Doubtful it will do either at this point. But we should expect the tax preference for charitable donations to resurface.

A tough issue, I think. Where do you net out?

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4 Responses to Charitable Deduction a Tough Issue for Tax Reform

  1. danmac says:

    I favor the cap including donations. As for the poor I see them as a community responsibility by which I mean the taxpayers. I’m of the there but for fortune go you or go I school of thought.

  2. Kathryn Baer says:

    Thanks for the comment, Dan. I appreciate your views.

    Like you, I’m not enthusiastic about using itemized deductions as a way of nudging people to perform favored actions. Among other things, as I said, it’s a regressive mechanism.

    However, I seriously doubt that we could get taxpayers to pick up the whole bill for services nonprofits provide for low-income people. Even if we could, there would still be problems.

    A big one, of course, is that charitable donations support a much wider range of nonprofits. Another is that direct taxpayer support for nonprofits could come with restrictions that severely limit services and advocacy. This is already the case with grants from the Legal Services Corporation.

    This isn’t to say that we shouldn’t view aid to poor people as a community responsibility. Only that, in the real world, I find the charitable donations issue difficult.

  3. Use the $40 billion charitable deduction only for contributions to those charities willing to sponsor 2,000,000 new jobs and internships. [In 2000 nonprofits had twice the net wealth of the poorer 50% of the U.S. population and today they have more than eight times the wealth].

  4. […] agrees that the tax code is way too complicated. But, as I’ve written before, there’s a big divide on what should be done with revenues gained by closing […]

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